Self-promotion alert: price-rent ratios edition

A reader has asked me to link to this article about what price-rent ratios are telling us about the state of the housing market. Price-rent ratio is basically the price of a house divided by the cost of renting an apartment—a measure of whether houses are more expensive than they should be. Here’s a taste:

At first pass, the data suggest we’ve largely come back to earth. The average price-rent ratio for the 54 metro areas Economy.com broke out was 19.8 for the three months through September, a couple of points higher than the 15-year average of 17.7 but significantly lower than where the ratio stood three years ago, 24.4. By doing some additional math (which we’ll explain later), we can surmise that house prices still have to drop 4.6% over the next five years, assuming the price-rent ratio returns to normal over that period. Funny how that almost doesn’t seem so bad at this point. And if we look at the entire U.S., which includes many rural areas unaffected by the house-price run-up, the picture is even better — we should be seeing average house-price appreciation of 2.2% over the next half-decade (again, assuming the price-rent ratio reverts to its 15-year average).

Granted, price-rent ratio is hardly the last word in predicting home prices. Economists who use these numbers (including those at Economy.com) take into account a lot of other factors when forecasting, like housing affordability, population trends and how incomes in an area are changing. Price-rent ratio is the quick and dirty way of doing it — but that also makes it more accessible. It’s easy to look at a price-rent ratio of 21.7 in Miami, compare it to a 15-year average of 16.8 and realize the market still has quite a bit of room to fall. Just like it’s simple to see a price-rent ratio of 13.9 in Indianapolis, line it up against a long-term average of 14.8 for that area and decide it might be time to start house-hunting. If you click here, you can see the breakdown for all 54 metro areas.

If you’re fuzzy on what I’m talking about when I say “price-rent ratio,” or if you simply care about data integrity and want to understand the caveats that go along with these numbers, click here to read the full story.

While you’re reading Time.com stories, you might also want to check out this one my colleague Steve Gandel wrote about why FICO scores are no longer the last word in assessing creditworthiness. ‘Bout time.

Barbara!

Stocks Rally Further in Run-up to EU Summit

MOSCOW — Global stocks enjoyed one of their best days in weeks on Tuesday ahead of a summit of European leaders that’s expected to be dominated by calls to boost economic growth.

Europe remains the focus of attention across all financial markets in the run-up to the June 17 Greek election that could go a long way to determining the country’s membership of the euro as well as the future of the single currency zone.

rrsafety

Hey Barbara and Justin,
How about taking it one step further and put together the “Kiviat-Fox Housing Price Direction Indicator” that would include both the Price/Rent ratio and the Median Price/Median Income ratio.

I’m not sure how one mathematically combines two ratios to create a telling number, but I’m sure someone out there does… is Bill James available?
plukasiak

nice article Barb… but I’d like to add a caveat that doesn’t appear in your piece.

Specifically, the study you cited assumes that rents are not inflated as a result of the home price bubble. To suggest that the rental market will not adjust to increased residential real estate prices is, at the very least counter-intuitive, and there is a very strong possibility (especially given the recessionary economy) that rents will go down in the coming year, making the rental/home price ratio far less encouraging than it is now.
rrsafety

Pluk, the 15 year average should be used as a point of comparison. That 15 year avg. should even out some of the bubbles.
plukasiak

re: the Gandel piece…
throughout the piece, he equates delinquency rates with foreclosure rates — but they aren’t the same thing. Simply being behind in a mortgage payment makes you delinquent, but that doesn’t mean that you’ll go into foreclosure.
_
the piece also suggests that phone bill payment data is relevant to whether one would default on one’s mortgage. While phone bills may be a good way of figuring out who is likely to pay their mortgage late, I don’t see any reason to believe that simply because one doesn’t pay their phone bill on time every month that they will default on a mortgage — paying all your utility bills “on time” is a measure of how anal a person is, rather than how fiscally responsible they are.
_
(I’m the kind of person who doesn’t pay my phone bill “on time”, but have never had my phone shut off for non-payment (or had bounced a check in the last 25 years.) Combine that with the fact that I assiduously avoid any kind of debt and pay cash for everything (if I want something, I save up for it) and I appear “non-creditworthy. This was especially annoying when I bought my second house. I owned my first house free and clear, and when I put it on the market it was easily worth 2.5 times what the next house cost. Yet, despite the fact that I had more than sufficient collateral to cover the price of the new home (and was putting down a 25% down payment), my lack of a good credit score meant that the only loan I could get was usurious.
_
(I wound up borrowing money from family members, and paid them back as soon as the old house was sold two months later).
_
Back in the “good old days” when banks knew their customers, and made loans based on far more rational criteria, I would have been able to get a good rate on a short term loan — and IMHO the centralization and depersonalization of the financial system is one of multiple factors in the financial crisis we’ve undergone.
plukasiak

Pluk, the 15 year average should be used as a point of comparison. That 15 year avg. should even out some of the bubbles.
_
the study compared 15 year average home prices to current, not “averaged over time” rents. If, as I suspect, rental prices are higher than they will be in the next year, using current rental prices to judge how far home prices will fall will result in an underestimation of the “bottom” of the market.
Barbara Kiviat

I take your point on rental prices, plukasiak. I actually have 5-year rental forecasts for all those markets, but I think that part of the data is proprietary and I’m not supposed to post the complete rundown. Some markets are due for a drop—Kansas City down an annualized 1.7%, Miami down 1.4%—but most are predicted to see increases. Dallas up 1.7% per year, Phoenix up 2.1%.
Barbara Kiviat

Oh, and rrsafety, funny you should mention that. I was talking to the Economy.com economist about something very similar. Haven’t done anything about it yet, though.
jgewargis

I would love to see Q2 2009 Price to rent ratios for Chicago…I am looking to buy a new home. Thanks!